Week 6 - Variable Costing, Segment Reporting, Cost-Volume-Profit Analysis

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Week 6 - Variable Costing, Segment Reporting,
Cost-Volume-Profit Analysis

• Chapter 8
• Chapter 9

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Chapter 8 - Variable Costing and Segmental
Reporting Traditional and ABC Approaches
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Learning Objectives
Learning Objectives

• Explain the differences between variable and
  absorption costing.
• Explain how variable costing is useful in
  evaluating the performance of managers.
• Prepare a segmented income statement based on a
  variable-costing approach and explain how this
  format can be used with activity-based costing to
  assess customer profitability.
• Explain how variable costing can be used in
  planning and control.

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A Comparison of Absorption and Variable Costing
Variable Costing
Absorption Costing
Accounting Information System
1. Treats fixed mfg. costs as a period
cost. 2. Used for internal reporting 3. Useful
for decision-making
1. Assigns all mfg. costs to products 2.
Fixed mfg. costs are inventoried 3. Used for
external reporting 4. Acceptable for tax
reporting
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A Comparison of Absorption and Variable Costing
Absorption Costing
Variable Costing
Accounting Information System
Product Costs Direct Materials Direct
Labour Variable Overhead Fixed
Overhead Period Costs Selling Costs
Administrative Costs
Product Costs Direct Materials Direct
Labour Variable Overhead Period Costs Fixed
Overhead Selling Costs Administrative Costs

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Costs Compared

• Estimated and Actual Costs
• Manufacturing
• Direct materials 100,000
• Direct labour 50,000
• Variable Overhead 80,000
• Fixed Overhead 90,000
• Total manufacturing cost 320,000
• Non manufacturing
• Variable selling 32,000
• Fixed selling admin. 100,000
• Total nonmanufacturing costs 132,000

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Units Costs Compared Contd

• Estimated and actual production
  100,000 units
• Sales 80,000 units
• Price 6.50 per unit
• Beginning finished goods -0-
• Unit Cost Variable Absorption
• Direct materials 1.00 1.00
• Direct Labour 0.50 0.50
• Variable overhead 0.80 0.80
• Fixed overhead ---- 0.90
• Total 2.30 3.20
• Value of ending finished goods inventory
• Variable Costing 2.30 x 20,000 46,000
• Absorption Costing 3.20 x 20,000 64,000

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Income Statement Analysis and Comparison

• Using data from earlier PPT slides
• I. Absorption Costing
• Sales (6.50 x 80,000) 520,000
• Cost of goods sold (3.20 x 80,000)
  (256,000)
• Gross Margin 264,000
• Selling and Administrative
  (132,000)
• Net Income 132,000
• II. Variable Costing
• Sales (6.50 x 80,000) 520,000
• Variable cost of goods sold (2.30 x
  80,000) (184,000)
• Variable Selling
  (32,000)
• Contribution Margin 304,000
• Fixed overhead
  (90,000)
• Fixed Administrative
  (100,000)
• Net Income
  114,000

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Income statements Analysis and Comparison Contd

• Absorption costing net income 132,000
• Variable Costing Net income 114,000
• Difference 18,000
• Explained
• Production 100,000
• Sales 80,000
• Increase in inventory 20,000
• Fixed overhead rate x 0.90
• 18,000

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Net Income Reporting Under Variable Costing
Sales
9,600,000 Less variable
expenses Variable cost of goods sold
6,400,000 Variable selling and admin.
320,000 6,720,000 Contribution margin
2,880,000 Less fixed
expenses Fixed overhead
500,000 Fixed selling and admin.
100,000 600,000 Net Income
2,280,000
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Net Income Reporting Under Absorption Costing
Sales
9,600,000 Less Cost of goods sold
6,800,000 Gross margin

2,800,000 Less Selling and admin. expenses
Variable expenses 320,000 Fixed
expenses 100,000
420,000 Net income
2,380,000 Fixed rate
500,000/20,000 25 per unit

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Production, Sales, and Income Relationships
If
Then Production gt Sales
Absorption NI gt Variable NI Production lt Sales
Absorption NI lt Variable NI Production
Sales Absorption NI Variable NI
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Advantages of Variable Costing

• Does not bury fixed costs in the cost of goods
  sold calculation.
• Enables one to focus on fixed costs.
• Enables one to perform incremental analysis and
  assists in decision making.
• Enables one to perform segmented reporting.
• Net income under variable costing is highly
  correlated with changes in sales and production.

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Disadvantages of Variable Costing

• Too much focus on the short-run.
• May ignore the impact of fixed costs on
  decisions.
• Very expensive to install.

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A Segmented Reporting Example

• Assume the following for a company with two
  product lines
• 
  Regular Deluxe
• Units of Sales 400
  200
• Units of Production 400
  200
• Sales Price per Unit 500
  750
• Sales Revenue 200,000
  150,000
• 1Unit production cost 240
  300
• 2Fixed Expenses 130,000
• 1Variable selling and administrative expenses
  amount to 5 of sales
• 2 Fixed manufacturing expenses amount to 90,000.
  Of that amount, 60,000 can be traced to each
  product on an equal basis. The remaining costs
  are common to both products.

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A Segmented Report for the XYZ Company
Assume the following
Regular Deluxe Total
Sales units
400 200 600
Sales revenue 200,000
150,000 350,000 Less variable
expenses Variable cost of sales
96,000 60,000 156,000
Variable selling admin. 10,000
7,500 17,500 Contribution margin
94,000 82,500 176,500
Less direct fixed expenses Direct fixed
overhead 30,000 30,000
60,000 Product margin
64,000 52,500 116,500 Less
common fixed costs
70,000 Net income

46,500

Note Sales in units Production in units
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ABC and Relevant Costing
Assume a company is considering a make or
out-source decision for 100,000 units of its
Deluxe product line at a price 155.50
Direct materials
1,500,000 Direct labour 3,500,000 Variable
overhead1 7,000,000 Variable selling and
admin. 2,250,000 Direct fixed
Supervision
100,000 Rental of special equip.
140,000 Total traceable costs
14,490,000 or 144.90 per unit Common fixed
costs 2,000,000 Should
these costs
be
considered? 1Assigned using a variable overhead
rate of 200 of direct labour costs
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Relevant Costing with ABC Analysis
Common fixed costs
1,600,0001
1st Stage Allocation (complete)
Resource Drivers
Engr. Support Matl Handling
Set-ups
Space/Util. 300,000 400,000
350,000
550,000
Engr. orders No. of Parts
Orders Square
feet
2nd Stage Allocation
Activity Drivers
Standard
Deluxe Product
Product
1Assume 1,600,000 of the 2,000,000 could be
traced using ABC.
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An ABC Example (Continued)
Data from ABC Study Revealed
Possible Drivers Standard
Deluxe

Units
produced 200,000 100,000
Number of orders 200
300 Number of tests
500 200
Number of parts
40 60
Engr. orders 50
250 Square feet of
space 14,000 6,000
Direct labour hours
2,000 3,500 Number of models
30 20

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An ABC Example (Continued)
Cost Driver Activity
Pool Pool Level Amount
Driver Rate
Engr. Support Products 300,000 300
models 1,000/order Matl Handling Units
400,000 14,000,000 parts
.029/part Set-up Batch
350,000 500 orders
700/order Space/Util. Facility
550,000 20,000 sq. feet 27.50/sq. foot
Please note that common fixed costs have
been converted to fixed costs with usage rates
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Common Cost Allocated to Products
Cost Pool Standard Deluxe
Total Matl Handling 228,560
171,440 400,000 Set-up
140,000 210,000 350,000 Space/Util.
385,000 165,000 550,000
Engr. support 50,000 250,000
300,000 Total 803,560
796,440 1,600,000
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Revised Segmented Report with ABC Analysis

Standard Deluxe Total Sales
units 200,000
100,000 300,000 Sales revenue
10,000,000 15,000,000
25,000,000 Less variable expenses
Variable cost of sales 6,000,000
12,000,000 18,000,000 Variable
selling admin. 1,000,000 2,250,000
3,250,000 Contribution margin
3,000,000 750,000 3,750,000 Less
direct fixed expenses Direct fixed overhead
180,000 240,000
420,000 ABC costs
803,560 796,440 1,600,000
Product margin 2,016,440
(286,440) 1,730,000 Less common fixed
costs
400,000 Net income

1,330,000

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Planning and Control

• Variable costing is useful because of its cost
  behaviour focus
• Variable costing loses it usefulness as it moves
  outside its relevant range.

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The End